You would think that beating the market is an outcome that goes hand in hand with being a professional trader. However, is that the case, do professional traders outperform the market consistently, if at all?
Statistically, only 15 percent of professional traders can beat the market in a given year. When you factor in the ability to beat the market persistently, less than three percent can do so over three years, and less than one percent over five.
Does this mean that professional traders are ineffective, or is there something missing in the calculus that the public uses regarding the concept of beating the market? This article will expand on professional traders and the idea of beating the market, especially why it may not always be the metric used to judge a trader’s performance.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
Understanding the Concept of “Beating the Market”
It is important first to understand what the term “beat the market” really means. In the trading world, beating the market requires a trader to outperform a market benchmark result over a determined period. The most common benchmark for this comparison is the S&P 500.
However, other benchmark markets can be used, such as the Dow Jones Industrial Average (DJIA). Additionally, for traders who specialize in trading a specific set of securities, benchmarks that are better aligned to their industry or sector can also be used.
Likewise, the period used to compare results can vary. Such comparisons between market performance and trader performance can be made using daily, weekly, monthly, quarterly, and annual time frames. However, yearly comparisons are the most common.
The Statistics on Professional Traders’ Performance
To properly gauge the performance of professional traders regarding their ability to beat the market, you need to look at the SPIVA US Scorecard. This report provides you with the performance statistics of domestic equity funds compared to that of the S&P 500 index.
The SPIVA scorecard presents these statistics for multiple timeframes as well as sectors and industries. Using the end-of-year scorecard for 2019 as an example, 86.9 percent of equity fund managers underperformed the S&P.
A more in-depth analysis of the results indicates that from 2009 to 2019, 89 percent have underperformed the S&P. When you extrapolate the results over multiple decades and across security classes and small-, mid-, and large-cap funds, it averages to 15 percent of traders in a given year beating their respective market benchmark. In other words, on average, 85 percent of professional traders underperform the market.
How Trading Styles Affect Performance Statistics?
While to the public, the preponderance of underperformance by traders in relation to the market’s performance might seem perplexing, it is not that surprising. Different professional traders will have different trading goals or mandates. A professional trader in an aggressive growth fund or a hedge fund may have more latitude for risk than a trader working for a mutual fund.
These differences are also present in traders who do not work for a fund but rather trade professionally as individual traders. In this case, the trading style and strategy of preference of the individual trader has a strong bearing on potential performance and beating the market.
For example, if you want to compare professional day traders to swing and position traders, there will be a large discrepancy in the volume of trades that they place. The former being involved with a greater number of trades than the latter.
Usually, the more volumetric the trader’s trading style, the more likely they will be to underperform the market. Such a consequence is not a negative reflection of volumetric trading strategies; these results are attributed to the fact that the approach usually requires the trader to be in an all-cash position at the end of the trading day.
Therefore, position traders, those who hold positions open for weeks or months, and swing traders, those who hold the position open for days or weeks, have a better opportunity to beat the market.
Another thing to consider beyond the professional traders’ trading style involves what is commonly known as the 80/20 rule—also known as the Pareto principle. It asserts that 80 percent of outcomes result from 20 percent of the inputs. When focused on trading, this broad rule implies that 80 percent of the profits will be derived from 20 percent of the trades made.
Applying more extended time frames—multi-year as opposed to yearly— and discounting the importance of continuous persistence in results would mean that a professional trader does not need to beat the market year over year. Underperforming for a few years while overperforming in others would still result in a worthwhile pursuit.
The Importance of Consistent Performance
What successful professional traders focus on more than unsuccessful traders is being consistent in their performance instead of persistently beating the market. In other words, mitigating risk and maximizing returns to show a positive return in the aggregate of their trades, not in trying to keep pace with the overall market performance for a specific period.
Focussing extensively on beating the market can result in trading decisions that can be detrimental to a trader’s position. It can result in trades that chase the market instead of being based on sound and methodical trading strategies.
Over the long haul, those professional traders who focus on consistent performance over beating the market quarterly or yearly stand a greater chance at beating the market in a multiyear or multi-decade time frame. Additionally, they will also outperform the market by a more considerable margin than other traders when they beat it.
Factors That Result in Unsuccessful Trading
While nearly every successful trader will have “losing streaks” and even off-years, there are traders at the professional level who lack the discipline, skill, or fortitude to succeed. It is not a reflection on them as people, nor is it an indication that they do not belong in the world of finance. Trading professionally requires a certain mindset and level of discipline that not everybody has. However, the allure of trading draws many into it even when it is not their forte.
As a result, the statistics that reflect the number of professional traders who beat the market are ladened with traders who have only been trading professionally for three years or less.
You can find the best example of this in day trading. Eighty percent of day traders quit within the first two years of starting to trade. By the fifth year of day trading, only seven percent remain as active traders. This statistic demonstrates the correlation between consistent performance and longevity in trading. Consistency is paramount.
It also highlights how in any given year, a significant number of traders are not beating the market, not for the acceptable reasons listed above, but for more fundamental reasons. The same reasons that will lead most of these traders to abandon trading within a few years. However, while they are in the trading profession, their lackluster performance will lower the statistics that reflect the number of traders that beat the market.
Author’s Recommendations: Top Trading and Investment Resources To Consider
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Conclusion
Statistically, few professional traders beat the market in a given year. However, that is not because the majority of traders are deficient in what they do. It is primarily due to differences in trading strategies, goals, and the fact that more extended time frames beyond a yearly outlook need to be considered to measure the success of a trader correctly.
Therefore, you can conclude that a professional trader can be successful even if they don’t beat the market year in and year out.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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